Winged, but is Qantas terminal?

John Addis

Make no mistake, the problems at Qantas have more to do with radically inept management than competition, cost structures and unionisation.

The question for investors is whether the plan to save $2 billion announced last Thursday makes Qantas a turnaround play. Members of the Qantas loyalty program face another issue; whether to spend their points now or hang on for better times.

Eventually, Qantas will get enough right to secure its future but it almost certainly won't do so under this management team. Photo: Michele Mossop

Airlines are difficult businesses. Only a handful return their cost of capital over the long term, and they tend to be low-cost carriers such as Southwest and easyJet rather than legacy carriers such as Qantas. If you're investing in airlines, the deck is already stacked against you.

Good management may deliver reasonable returns for a while but as soon as the economy deteriorates, the share prices of even well-managed airlines plummet. The problem with Qantas is that the board has proved itself so poor that the case for making an investment is hard to justify at any price.

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In October 2011, in an attempt to win an industrial dispute, Alan Joyce grounded the airline, leaving passengers stranded. He correctly described it as an ''unbelievable decision''. The story made headlines worldwide and cost Qantas shareholders $70 million in cash and an untold fortune in goodwill.

The grounding also opened the door to a resurgent Virgin, which former Qantas employee and current Virgin chief executive John Borghetti took with relish. This was the beginning of the great Qantas decline, one then compounded by a huge error.

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Joyce persisted with his predecessor's ''line in the sand'' approach. Qantas, he said, would not let its domestic market share drop below 65 per cent. The airline's now famous declaration that ''where Virgin puts on one aircraft we will put on two'' is a textbook definition of business irrationality, one that has consigned the airline to future losses that, by the time it is reversed, will have cost shareholders hundreds of millions of dollars.

Last Thursday, Joyce stressed the need to end unprofitable routes but failed to mention that this was what his strategy delivered.

The perplexing thought bubbles weren't mentioned, either. What happened to the ludicrous plan to set up an Asian business-only airline? How much has Jetstar Asia lost since it began operations? And does Qantas make anything from the traffic it has gifted to Emirates?

Few chief executives admit their errors, especially not those looking to dip their hand into the taxpayer's pocket. For the car companies, Coca Cola Amatil and Qantas, it's always someone else's fault. Shareholders are now being asked to back the architects of Qantas' demise with their new plan, with a bit of government support thrown in. It's a bit like being rear-ended by a dangerously incompetent motorist and then him asking you for a lift home.

Sir Humphrey Appleby of Yes, Minister might describe an investment in Qantas as ''courageous''. That's one way of putting it. There are 23 stocks on Intelligent Investor Share Advisor's current buy list. Each offers either a more secure or a potentially more lucrative return. Eventually, Qantas will get enough right to secure its future and capitalise on the strange, proprietorial affection many Australians have for it. But it almost certainly won't do so under this management team. It's a stock best avoided.

Now, what about those frequent flyer points?

The Qantas loyalty program is as wonderful a business as the airline is a poor one. Companies such as Woolworths and the banks pay for points from Qantas that are then offered as rewards to their loyal customers.

But these points aren't redeemed for years, and sometimes not at all. And when they are, it's for a seat on a flight that would probably be otherwise empty. So Qantas gets a high price for the points it sells but pays a very low one, sometimes many years later, when those points are redeemed. That makes the loyalty business exceptionally profitable, and explains how it boosted its pre-tax profit from $607 million to $662 million in the past six months. Unfortunately, that's bad news for your points.

With the rest of the airline struggling, Qantas will look to the loyalty arm to make even more money. One easy way of doing that is to slash the value of your points by increasing the amount you have to redeem for a flight. Service charges and limiting reward seats are other areas for Qantas to increase the already-incredible margins in its loyalty business. So it's going to get more expensive to redeem your points and harder to use them. Better spend them now and get what little value remains.

John Addis is a director of Intelligent Investor Share Advisor.

This article contains general investment advice only (under AFSL 282288).

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